An Ontario judge has approved Ernst & Young LLP’s $117-million settlement of a shareholder class-action lawsuit tied to the collapse of Sino-Forest Corp.

The settlement was reached late last year, but was opposed by a group of institutional shareholders that wanted the option of opting out of the settlement and filing suit against the auditor on their own. They argued that the settlement should not fall within Sino’s court-ordered restructuring process.

But Justice Geoffrey Morawetz ruled that the E&Y settlement is a necessary part of Sino’s restructuring plan. He noted that under the plan, that there is no payment to Sino’s stakeholders outside of the cash from E&Y.

“The significant and, in fact, only monetary contribution that can be directly identified at this time, is the $117-million from the Ernst & Young settlement,” he wrote.

Judge Morawetz also concluded that the E&Y settlement is “fair and reasonable” and provides “substantial benefits” to relevant stakeholders. And he believes that the claims against E&Y could “significantly delay” Sino’s restructuring process if they were not resolved within this settlement.

The $117-million settlement is the largest payment ever made by an auditor in Canada to settle a class-action suit. E&Y is also facing allegations from the Ontario Securities Commission, which argued that it did not do enough to verify Sino’s ownership of its assets. Sino-Forest filed for bankruptcy protection last year amid allegations that it was committing massive fraud, and is now controlled by its creditors.

An Ontario judge has approved a restructuring transaction in which the assets of Sino-Forest Corp. will be transferred over to the company’s bondholders.

The decision was made despite last-minute opposition from a group of institutional shareholders, who were upset about how the deal is structured. The transaction includes Ernst & Young’s LLP’s proposed $117-million settlement of class-action claims related to Sino’s collapse.

The shareholders, which include Trimark Investments, Comité Syndical National de Retraite Bâtirente Inc. and Northwest & Ethical Investments LP, want the option of opting out of the settlement and suing Sino on their own. If the settlement is approved, they would not have that option. They asked the court to either delay approval of the restructuring, or carve out the E&Y settlement.

Last Friday, lawyers representing Sino’s other stakeholders argued in the Ontario Superior Court of Justice that the E&Y settlement still needs further court approval. Therefore, the investors can challenge it at a later date without needing to halt the restructuring transaction.

Justice Geoffrey Morawetz agreed with that perspective. “The arguments put forward by counsel on behalf of the funds are premature,” he wrote in a decision released Monday night.

John Mountain, senior vice president of NEI, said he was still happy with the result, which clarifies that the E&Y settlement is not a done deal. “We are thrilled with this decision that at this point there is no limit on the potential liability of any of the other defendants. It is a great decision from our perspective,” he said in an emailed statement.

The three shareholders hoping to opt out of the settlement own about 1.5% of Sino-Forest shares. They are represented by Kim Orr Barristers PC, which tried to win “carriage” of the Sino class action claims but lost out to Siskinds LLP and Koskie Minsky LLP.

Getting the restructuring transaction approved quickly was crucial, lawyers said Friday, as the company’s business is on the verge of complete collapse in China.

While E&Y has settled, Siskinds and Koskie Minsky are still pursuing claims against the other defendants, which include Sino-Forest itself, former officers and directors, BDO LLP, and the firm’s numerous underwriters.

The Ontario Securities Commission is not finished making allegations against Sino-Forest Corp.

On Wednesday evening, the scandal-plagued firm announced that it received a second enforcement notice from the staff of the commission. It includes a new allegation that is “similar in nature” to the ones the OSC previously made, Sino said.

Enforcement notices are typically sent out near the end of investigations, shortly before the OSC makes formal allegations. They give the respondents a final opportunity to make their case.

The OSC first sent notices to Sino and six of its former executives in April. Six weeks later, it accused the company of orchestrating a massive fraud by conducting phony purchase and sale transactions with third parties over which it had “undisclosed control.”

Sino-Forest said it is reviewing the second enforcement notice and is considering what steps are appropriate.

The Chinese forestry company filed for creditor protection last March, and is in the midst of a major restructuring that passes control of its assets over to noteholders.

Retail investors holding shares of Sino-Forest Corp. have turned to veteran securities lawyer Joe Groia to try to get a voice for themselves and wring some value from the insolvent Chinese forestry firm.

Mr. Groia has not agreed to act in an official capacity yet, but he is doing some pro bono investigative work to see if there is a strategy he can pursue on behalf of shareholders.

“For me to say we have a gameplan would be putting the cart before the horse at this stage,” he said in an interview. “I’m not altogether sure there’s a lot that can be done. But we want to look carefully at potential sources of recovery.”

Ever since short seller Muddy Waters LLC published a report accusing Sino-Forest of fraud last year, the retail shareholders have been furious about how the process played out. They believe the Ontario Securities Commission over-reacted when it halted the stock, and that they are being wrongly shoved aside as the CCAA process plays out.

Shareholders were initially told they might receive a portion of the new company that would emerge from Sino’s restructuring transaction, but that is no longer the case. They were also removed from the litigation trust that was set up to pursue a lawsuit against Muddy Waters. They were originally supposed to receive as much as 100% of it.

Mr. Groia referred to the shareholders’ plight as a “very complicated situation.”

“You could turn this into a very good law school examination question. It’s not something that’s going to have a quick and easy solution.”

Mr. Groia is best known for his successful defence of Bre-X geologist John Felderhof. The Law Society of Upper Canada recently said that he violated civility rules during that trial.

All six executives are no longer in their positions. Chairman emeritus Allen Chan and chief financial officer David Horsley resigned, while three employees were terminated: Alfred Hung, George Ho and Simon Yeung. They were first placed on administrative leave last August. Former vice president Alfred Ip had previously resigned, but the company said he will not serve as a consultant.

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They all received enforcement notices earlier this month from the OSC, a sign that the commission is close to bringing formal action against them. With the exception of Mr. Horsley, they were all singled out last August, when the OSC cease-traded the stock and alleged that certain insiders at Sino-Forest committed acts that they “know or reasonably ought to know perpetuate a fraud.”

Enforcement notices are sent out near the end of investigations. They give the targets a small window, typically about 10 to 14 days, to explain their actions and avoid formal allegations.

Mr. Chan, who resigned as CEO last year once the stock was cease-traded, decided to resign as chairman emeritus as well once he received the enforcement notice.

With regards to Mr. Horsley, Sino noted in a statement that the allegations in the enforcement notice against him “differ substantially” from those directed at the other individuals. As a result, Sino decided to keep him on to assist with its restructuring efforts even though he will no longer be CFO.

Sino-Forest was forced into creditor protection last March after being unable to file its financial results due to unanswered questions about its third-party relationships in China. The company is now running a process to try and sell its assets. If that fails, the business will come under control of the bondholders, who own US$1.8-billion of the company’s debt.

Sino has operated under a black cloud since last June, when short seller Muddy Waters LLC accused it of fraud. An independent committee was set up to look into the allegations, but it failed to unwind the company’s third-party relationships despite a 10-month, $50-million investigation.

]]>http://business.financialpost.com/news/sino-forest-founder-chan-resigns-in-corporate-shakeup/feed/0stdSino-Forest said Allen Chan, who stepped down as chairman and chief executive in August, has resigned from his position as "founding chairman emeritus".Sino-Forest gets creditor protection extensionhttp://business.financialpost.com/news/fp-street/sino-forest-gets-creditor-protection-extension
http://business.financialpost.com/news/fp-street/sino-forest-gets-creditor-protection-extension#commentsFri, 13 Apr 2012 20:17:55 +0000http://business.financialpost.com/?p=163197

TORONTO — An Ontario judge has extended creditor protection of scandal-plagued Sino-Forest Corp. to June 1, giving the company a longer period of security as it pursues a sale process.

The protection was scheduled to expire on April 29, and an army of lawyers met in the Ontario Superior Court of Justice on Friday to debate how long it should be extended, as well as other matters. Sino-Forest wanted protection extended to July 9, which the company said would provide certainty for potential buyers over the course of its sales process.

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However, the lawyers representing shareholders in a class-action suit against Sino wanted the protection to last no longer than 30 days.

Lawyer Ken Rosenberg of Paliare Roland Barristers said that reflects a lack of confidence in the company and its board of directors. Justice Geoffrey Morawetz decided on June 1, a midpoint between those dates.

He said he is satisfied that the parties are working in good faith under the creditor protection. Sino filed for protection late March, after being unable to file its 2011 financial results because of unanswered questions about its relationships in China.

The Ontario Securities Commission recently issued enforcement notices to the company and six of its current and former executives.

TORONTO — The Ontario Securities Commission is preparing to launch formal action against Sino-Forest Corp. and several of its insiders as it nears the end of an exhaustive 10-month fraud investigation into the collapsed forestry company.

The OSC has sent so-called enforcement notices to Sino-Forest and six individuals: former chief executive Allen Chan, chief financial officer David Horsley, Albert Ip, Alfred Hung, George Ho and Simon Yeung. With the exception of Mr. Horsley, all of them were previously singled out by the commission.

Enforcement notices are sent out near the end of investigations, shortly before the OSC launches formal proceedings. They give the targets a small window, typically about 10 to 14 days, to explain their actions and avoid the allegations. Replying to such notices is tricky, according to securities experts, because the responses are on the record and can be used against the targets.

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Sino-Forest did not provide details of the notice, but said the allegations are consistent with the OSC’s statements last August, when it cease-traded the stock and said that company insiders appeared to commit acts that they “know or reasonably ought to know perpetuate a fraud.” At that time, the OSC also stated that Sino-Forest appeared to engage in “significant non-arms length transactions” and may have misrepresented its revenue and timber holdings.

The third-party transactions are of particular concern for regulators, especially those involving a firm called Huaihua Yuda Wood Co. Ltd. The OSC cease-traded Sino-Forest shares one day after Mr. Yeung, then a senior manager at Sino-Forest, explained that he signed an acquisition agreement on behalf of Yuda Wood because the owner was out of town and Mr. Yeung was “performing a favour” for him.

If Sino-Forest produced something new at this stage to get the OSC to back off, it would be highly surprising for onlookers. The company’s independent committee spent about $50-million conducting its own investigation, yet still failed to unwind the company’s third-party relationships.

In some cases, companies do avoid formal OSC allegations after receiving enforcement notices. One recent example is Manulife Financial Corp., which received a notice in 2009 related to the disclosure of risk in its segregated fund and variable annuity products. The OSC made no formal allegations and eventually closed the file.

Sino-Forest has been operating under a black cloud since June 2 of last year, the day that short seller Carson Block of Muddy Waters LLC accused it of fraud. The fraud allegations ground the business to a halt, as Sino-Forest struggled to collect payments from customers, lost access to offshore banking facilities and fell out of favour with the Chinese government.

The company was forced into creditor protection at the end of March, as it could not file financial statements because of unanswered questions about its relationships in China. Longtime auditor Ernst & Young also resigned last week.

It’s not a stretch to conclude that a report on the poor governance practises among emerging market companies listed on Canadian exchanges underscores that many offshore firms raising money in this country operate with an alarming degree of impunity.

According to a 24-page staff review, released Tuesday by the Ontario Securities Commission, corporate governance “deficiencies” abound at most of the two dozen foreign issuers it scrutinized that are listed on the Toronto Stock Exchange or the TSX Venture Exchange.

The regulator rather politely referred to the failings as a “form over substance” approach to compliance.

“In our view, the level of rigour and independent-mindedness applied by boards, auditors and underwriters in doing their important jobs – management oversight, audit, due diligence on offerings – should have been more thorough,” the OSC report concludes.

As of last April, 108 issuers from China, Asia, Africa, South America and Eastern Europe fell under this category. Given that they had a total market capitalization of just over $40-billion, the litany of corporate governance violations uncovered by the report should answer the question of whether Canadian investors are exposed to inappropriate risks with a resounding “yes.”

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So what does the country’s top securities regulator suggest should be done to remedy a problem that everyone already knew existed?

For one, don’t take any of the blame. The report points a finger at boards of directors, underwriters, auditors and stock exchanges, but fails to acknowledge the commission’s own role in allowing these troubling foreign corporate practises to wash up on Canada’s shores.

“Staff expect that EM [emerging market] issuers, their auditors, underwriters and their other advisors, as well as the exchanges, will address the concerns identified in this report and will, where necessary, take immediate steps to improve their practices to effectively discharge their responsibilities to protect investors in Ontario,” the report declares.

What about OSC staff? Its own review admits that many of the potentially problematic issuers examined were initial public offerings whose preliminary prospectuses would have been analyzed and approved by folks at the regulator before being allowed to list in Canada.

Clearly, the provincial watchdog could also be doing better in its gatekeeper role.

So could the TMX Group, which owns the TSE and the TSX Venture exchange. These folks scour the world attracting companies to list in Canada as long as they meet certain basic listing requirements. Given that TMX is a private, for-profit company, it’s not surprising it would focus on volume.

Still, TMX operates under a license granted by the provinces and the various securities commissions approve its rules. Thus, it shoulders some responsibility because problems with a company listed on the TSX reflects on the credibility not only of the exchange, but the other companies trading on it.

The TMX, which worked closely with the OSC on the report, said it has already launched its own consultations to develop new guidance for emerging market companies.

Perhaps the most disappointing aspect of the OSC’s review is what it fails to deliver. That lax governance abounds at many of these offshore companies is already well known in the marketplace, especially given the problems with Sino-Forest Corp. and Zungui Haixi Corp.

What would have been more helpful as a result of the nine-month study is the emergence of a concrete blueprint to fix the shortcomings. Unfortunately, all the OSC advocates is further study in the hope that new policies will eventually be developed.

In all, there are 24 recommendations for improving the governance practices of Canadian boards of directors overseeing foreign companies, including better disclosure standards and risk-management processes. Ditto for underwriters and auditors, who according to the OSC, displayed a level of professional skepticism and rigor that was found “lacking.”

Still, of the companies found to have “significant” problems only one was referred to the OSC’s enforcement branch for investigation.

In the end, the lack of accountability permeates this well-intentioned and long-overdue assessment of emerging companies in Canada. With no marching orders, no deadlines, no timetable or specific targets, this report would have benefited from a little less sizzle, and a lot more substance.

A targeted probe by the Ontario Securities Commission of foreign firms listed on Canada stock exchanges has unearthed “concerns” about the work of boards, auditors and underwriters.

“This review uncovered a number of areas where issuers and gatekeepers need to improve in order to meet their obligations and we will be monitoring their progress to ensure the interests of investors are placed first,” said Howard Wetston, chair of the OSC.

Tyler Anderson/National PostThe OSC launched the targeted probe last July, after the share price of Chinese timber company Sino-Forest Corp. was felled by a short-seller’s laundry list of allegations including inflation of assets and fraud.

The report concluded that “the level of rigour and independent-mindedness applied by boards, auditors and underwriters in doing their important jobs — management oversight, audit, due diligence on offerings — should have been more thorough.”

The OSC launched the probe last July after the share price of Chinese timber company Sino-Forest Corp. was felled by a short-seller’s laundry list of allegations including inflation of assets and fraud. None of the allegations have been proven.

The OSC probe examined 24 listed firms that operate in a number of emerging-market countries and industries including mining, forestry, financial services and technology. The firms represent more than 50% of the emerging-market issuers with Ontario as the principal regulator.

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The report found shortcomings in the understanding of local business practices and the “degree of reliance” placed on local members of management.

“For instance, we observed situations in which it appeared that board members relied solely on a member of management to provide an overview of key business documents in a foreign language and did not obtain appropriate translations in order to read and assess the documents themselves,” the report said.

Among auditors, the report said, the “level of professional scepticism … when examining the information gathered in the course of their audit was generally lacking,” and there were instances where “auditors should have been uncomfortable based on the work performed and information received.”

Underwriters were similarly called out for missing or failing to disclose “red flags” such as “unusual year-over-year growth results” and financial metrics that were superior to an industry average.

The OSC, Canada’s largest capital markets regulator, said identifying “areas of concern” and recommending changes to protect investors and strengthen the integrity of the markets are the “ultimate goals” of its review and report.

]]>http://business.financialpost.com/news/fp-street/osc-report-on-foreign-firms-targets-directors-auditors-underwriters/feed/0stdosc_npThe OSC launched the targeted probe last July, after the share price of Chinese timber company Sino-Forest Corp. was felled by a short-seller’s laundry list of allegations including inflation of assets and fraud.Muddy Waters losing investors’ supporthttp://business.financialpost.com/news/fp-street/muddy-waters-losing-investors-support
http://business.financialpost.com/news/fp-street/muddy-waters-losing-investors-support#commentsMon, 27 Feb 2012 18:53:13 +0000http://business.financialpost.com/?p=146027

By Ye Xie and Nikolaj Gammeltoft

Carson Block, the short seller and analyst who sparked a 74% drop in Sino-Forest Corp. shares when he said the company misstated its business, is finding it harder to attract believers to his latest research.

The 35-year-old lawyer who founded Muddy Waters LLC gained credibility in June when he told investors that Sino-Forest overstated its timber holdings. Block’s reports on Chinese companies shook investors in the world’s fastest-growing major economy and helped erase more than US$5-billion of market value. The calls caused losses for John Paulson, the billionaire who got rich betting against subprime mortgages, and former American International Group Inc. Chief Executive Officer Maurice “Hank” Greenberg.

His latest opinions aren’t getting the same reaction. While Focus Media Holding Ltd. sank 39% when Muddy Waters said Nov. 21 that the Shanghai-based digital advertiser exaggerated its network, the stock has rebounded 57%. Spreadtrum Communications Inc., a chipmaker in Shanghai, traded at US$16.02 by 11:35 a.m. in New York, from US$12.49 on June 28, when Block questioned its revenue. Focus Media and Spreadtrum say the firm’s assertions lack merit.

“Carson pointed at a lot of things, but what seems to be lacking is a present-day smoking gun,” said Eric M. Jackson, founder and managing member of Ironfire Capital, a Naples, Florida-based hedge fund that invests in Chinese stocks. “It’s a tougher job.”

Reverse Merger

Block said on June 2 that Sino-Forest, a timber plantation operator based in Hong Kong and Missassauga, Ontario, claimed to own land that didn’t show up in government records. Sino-Forest, one of more than 300 Chinese companies listed in North America, lost $3.3-billion of market value after the report was released and hasn’t traded since August.

The company said on Feb. 1 that a committee of directors may not be able to disprove some statements as the information may not exist or be retrievable. Paulson, 56, sold his stake following Block’s report and booked a loss of $106-million.

The Securities and Exchange Commission cautioned investors in June about buying stakes in so-called reverse mergers, a process that involves buying a publicly traded shell company, saying they may be prone to “fraud and other abuses.” The Bloomberg Chinese Reverse Mergers Index, which tracks stock of 73 such companies, has lost more than half its value over the past two years.

Block, who founded a self-storage company in Shanghai after moving there in 2005 with a law degree, started Muddy Waters in 2010. He became the face of the short-selling wave against Chinese companies after his research led regulators to suspend trading in four of his first five targets, including Sino-Forest.

Hong Kong-based China MediaExpress Holdings Inc., which counted Greenberg’s C.V. Starr & Co. as a top shareholder, was suspended after Block said in February 2011 that the company was inflating profit. MediaExpress said the assertion lacked merit. Deloitte Touche Tohmatsu Ltd., a global accounting firm, resigned as auditor six weeks after Block’s report.

Muddy Waters, which says readers of its research should assume it has a short position, is having less success persuading investors to bet against his targets amid a new bull market in global equities.

While Focus Media slid to US$15.43 from US$25.50 when Block said the company was being run “solely for the benefit of insiders,” it has rebounded to US$24.13. Muddy Waters said Focus Media has fewer television screens in its ad network and that it may have overpaid for takeovers to mask losses.

Counting Screens

Market surveys conducted by Ipsos SA, a Paris-based polling company, and its unit Synovate in more than 100 cities showed that the number of LCD screens and poster frames reported by the Chinese company was more than 99% accurate, Focus Media said. While some of the company’s acquisitions haven’t been successful, assertions of fraud are “without foundation,” Focus Media said on Nov. 22.

Focus Media is “a legitimate business” and Block failed to provide new information on its acquisitions because the deals are publicly disclosed, said David Semple, director of international equity at the Van Eck Emerging Markets Fund in New York, which oversees US$35-billion, including Focus Media shares.

“You are looking at the stuff in the past and people knew about it,” said Semple. “Why bring it up now? They didn’t even bother to check with the company to find it out.

Spreadtrum is up 24% since June 27, the day before Muddy Waters said it was betting that the stock would fall in an open letter to management.

Regulatory Scrutiny

The shares are rebounding at a time when Chinese stocks trading in the U.S. are attracting more interest from investors and regulators. A gauge of Chinese and Hong Kong stocks listed in the U.S. lost 52% since its January 2011 peak after short sellers said companies including Sino-Forest were manipulating their financial information, embezzling money and lying about factories and customers.

“Unfortunately, there are still China frauds out there and these companies are willing to do almost anything to continue perpetrating that fraud,” Block said in an e-mailed statement.

Block “really opened a new chapter in exposing frauds,” said Sahm Adrangi, founder of New York-based hedge fund Kerrisdale Capital Management LLC, which is shorting Focus Media. “People just weren’t putting forward the resources to analyze these companies top to bottom as Carson did.”

Short Returns

Adrangi’s US$75-million fund returned almost 200% last year by betting against Chinese companies, according to data compiled by Fairfield, Iowa-based BarclayHedge, which tracks fund performance.

Focus Media, with a market value of US$3.3-billion, is the largest among the eight Chinese firms Block has targeted since June 2010 after Sino-Forest, according to data compiled by Bloomberg. Spreadtrum has a market capitalization of US$787-million.

Unlike Sino-Forest and China MediaExpress, which were listed on exchanges in North America through reverse mergers, Focus Media and Spreadtrum sold stock via initial public offerings.

The decline of reverse mergers is limiting the profit on short positions and it’s more challenging to prove transgressions by bigger companies, said Kevin Carter, co- founder and chief executive officer at Walnut Creek, California-based Baochuan Capital Management LLC.

‘Real and Substantive’

“To find something that is real and substantive and leads to the permanent demise of the business, those things are very hard to do,” said Carter, who holds shares of Focus Media. “They don’t have any more chances.”

Jing Lu, an investor-relations officer at Focus Media in Shanghai, didn’t return two e-mails and phone calls. Spreadtrum declined to comment on its share performance, said an official who asked not to be identified according to company policy.

The Chinese companies are protecting their stocks by buying shares and paying dividends.

Spreadtrum declared a 9.5-cent dividend on Dec. 23 and said that month that it will buy back as much as US$50-million of its American depositary receipts.

Focus Media said last month that it will use as much as 55% of its net income in the previous fiscal year to pay dividends or buy back shares. Chief Executive Officer Jason Jiang and Hong Kong-listed Fosun International Ltd., Focus Media’s two largest shareholders, bought US$21-million of ADRs on Nov. 22. The company responded to each of Muddy Waters’ five reports, rebutting the short-seller’s claims point by point.

CEO Commitment

“When the CEO shows a commitment to the company by buying a significant amount of shares, that sends a sense of confidence to investors,” said Kevin Pollack, a fund manager at Paragon Capital LP in New York, which invests in U.S.-traded Chinese stocks.

Block said on June 28 that he sees “a high risk of material misstatements” in Spreadtrum’s financial reporting, citing a six-fold surge in inventory in 2010. Block also questioned why then Chief Executive Officer Ping Wu and Chief Financial Officer Richard Wei left the company months before it reported 137% revenue growth in the third quarter of 2009 over the previous quarter. Sales increased 230% in 2010 from a year earlier.

Turned Around

Spreadtrum’s CEO Leo Li told investors during a conference call on June 29 that the inventory increase was due to the introduction of new products. Li said in an interview the same day that the company had neither customers nor a sales pipeline under the previous management. Spreadtrum turned around after developing new products once he became president in November 2008, Li said.

Analysts are rallying behind the companies. Six of eight analysts surveyed by Bloomberg since December have a “buy” rating for Focus Media.

Concerns over the allegations made in Block’s reports are overblown, Catherine Leung, an analyst at Goldman Sachs Group Inc., said in a Feb. 1 report, setting a “target” of US$43 for the shares.

Ten of 13 analysts have recommended buying Spreadtrum since December. Analysts at RBC Capital Markets and Dundee Securities, who had championed Sino-Forest’s stock before Block’s allegations, suspended their coverage within a month of Muddy Waters’ report.

Ironfire’s Jackson says Block has helped weed out questionable Chinese companies listed in North America and tempered overly bullish investor sentiment. The chances of a repeat are limited because share prices are already depressed and the bigger companies have more resources to fight back, Jackson said.

“Easy money has been made,” Jackson said. “It’s going to be a harder job for him if he wants to continue to short these Chinese companies.”

When Sino-Forest Corp.’s independent committee released an interim report on its investigation last November, the company held it up as vindication and proof that it was a viable entity and not a fraud.

There was no celebrating this time.

The committee’s long-anticipated final report was a disappointment all around. It failed to respond to key allegations from Muddy Waters LLC, and in doing so, did not provide a clear road forward for the company. The report actually raised brand new questions about Sino’s business model by introducing a new layer of complexity.

“It is just stunning that so inconclusive a report would stem from such a time consuming and costly process,” said Dimitri Lascaris, a partner at Siskinds LLP who is leading a class action against Sino-Forest.

In order to become viable again, Sino needs to file its financial results, fend off a criminal probe by the Royal Canadian Mounted Police, and convince the Ontario Securities Commission that its cease trade order should be lifted. Those will be extremely difficult tasks after the committee admitted it could not unwind the company’s web of third party relationships. As a result, investors still cannot rely on prior disclosures.
“Much of the information which [the committee] is seeking lies with non-compellable third parties, may not exist or is apparently not retrievable from the records of the company,” the report said.

Nonetheless, it is understood that Sino’s management is relieved the report is finally finished, as it can now focus on how to restructure the business. The key player in those talks will be the bondholders.

Bondholders have a say over all of Sino’s decision-making after they agreed to waive a debt default in December. They demanded that a strategic plan be in place by the end of March, and will have a say over any potential asset sales or capital raising.

The report puts them in a difficult position. They are still lacking important information about third party relationships that would be helpful in reviving the company. On the other hand, liquidating the assets in China would bring its own challenges.

The committee report reinforced that Sino has a byzantine business model that would be tough to unwind. For example, the report revealed the existence of a previously unknown third party known as “backers,” calling them “individuals with considerable influence” who work with both Sino’s suppliers and the “authorized intermediaries” through whom it sells product.

The committee lacked information about the backers, and could not reach any conclusion on the “existence, nature or importance” of relationships between them and Sino-Forest.

“The backers, in my mind, are the customers,” said Susan Mallin, an investment advisor at MGI Securities who has followed the Sino affair closely. She has been a vocal defender of the company.

Speaking from the opposite perspective, Mr. Lascaris said he has a hard time seeing any viable road forward for Sino after the committee could not confirm that its past disclosure documents were accurate.

“How would any self-respecting auditor sign off on [Sino’s financials]?” he said.

“They appear to have quite a challenge ahead of them, and that should not surprise anyone.”

Beleaguered forestry firm Sino-Forest Corp. has been slapped with a new class action lawsuit out of the United States that accuses it of multiple acts of fraud.

The case, which was filed by Cohen Milstein Sellers & Toll PLLC, is targeting potential plaintiffs who bought Sino-Forest shares on the over-the-counter (OTC) market in the United States. In addition to the company itself, the defendants include senior management, auditor Ernst & Young LLP, and underwriters Bank of America and Credit Suisse.

Sino has already been sued multiple times in Canada, and earlier this month, an Ontario judge awarded “carriage” of the Sino class action litigation to Siskinds LLP and Koskie Minsky LLP.

Launching a class action against a Canadian company out of the U.S. is more challenging, as there are limits on the ability of U.S. firms to sue companies that are not listed on U.S. exchanges. This suit only targets investors who bought the stock on the OTC market, rather than the Toronto Stock Exchange. The statement of claim for the Cohen suit refers to the OTC market as “open, well developed and efficient,” and noted that there was a “substantial” amount of trading of Sino-Forest shares on it. There are also restrictions on making claims in the U.S. related to federal securities law, which this suit tries to get around by making allegations of common law fraud and unjust enrichment, among others.

The new statement of claim, which was filed last Friday, includes similar allegations of false and misleading statements that were seen in the prior class action suits against Sino-Forest. There are 11 different counts against the company.

Sino-Forest, which was once Canada’s biggest forestry company, has been operating under a black cloud since June 2 of last year, when short seller Muddy Waters LLP accused it of fraud. The company quickly set up an independent committee to investigate the allegations, while the Ontario Securities Commission and Royal Canadian Mounted Police also opened investigations. The OSC halted trading of the stock in August, saying that certain company insiders committed acts that they “know or reasonably ought to know perpetuate a fraud.”

Sino recently breached its debt covenants, and barely avoided collapse by striking a deal with bondholders that gave them a great deal of influence over the company. The bondholders now have a say over all of the company’s major corporate decisions, including likely asset sales in the future.

The new lawsuit has come to light shortly before Sino’s independent committee is expected to release the final report from its investigations into the fraud allegations against the company. The committee said that the report would be released before the end of January.

The committee was not expected to complete its work until later this year. But under the deal with Sino’s bondholders, it agreed to the earlier deadline.

Sino-Forest Corp. said it is “optimistic” that it will reach a deal with bondholders to waive a default breach on the company’s US$1.8-billion of debt.

The scandal-plagued forestry firm received notices of default on Dec. 16 regarding its senior notes, which triggered a 30-day period for the company to address the breach. Sino warned that it will not be able to file its overdue third quarter results and cure the default within 30 days, as its special committee is still trying to complete its investigation.

However, Sino is in talks with the noteholders, and is optimistic that holders of a majority of its debt due in 2014 and 2017 will agree to waive the breach. That would give the committee more time to finish its work and allow Sino-Forest to potentially become viable again.

“The company and the ad hoc committee have negotiated the terms under which the defaults under the senior notes will be waived,” Sino said in a statement.

Shares of Greenheart Group Ltd., a public timber company controlled by Sino-Forest, jumped 50% in Hong Kong trading on the news.

Sino has been operating under a black cloud since last June, when short seller Muddy Waters LLC accused the company of fraud. The Ontario Securities Commission halted trading of the stock in August.

As the committee’s investigation into the company continues, Sino warned that its historic financial statements and related audit reports should not be relied upon. The committee is trying to unravel the company’s complex web of third party relationships and get answers to questions about unusual documents. The OSC and the Royal Canadian Mounted Police are also investigating the company.

The largest shareholder in Sino-Forest Corp. is very unhappy about the company’s decision to forgo a debt payment due this week.

The Singapore-based Richard Chandler Corp., which owns about 19.5% of Sino-Forest shares, issued a public statement on Wednesday that criticizes the company for not making the US$9.775-million interest payment on its 2016 convertible notes. The move has raised speculation that the bondholders will force the company into insolvency and the shareholders will be wiped out.

Alan Kelly, senior advisor to the Richard Chandler Corp., pointed out that Sino-Forest “clearly” has the financial strength and liquidity to meet its bond commitments.

“In view of its strong cash reserves and liquidity, and excellent bond repayment track record, we urge the Sino-Forest board to reconsider meeting its bond commitments, as it has always done,” he said in a statement.

Sino-Forest, the beleaguered Chinese forestry company accused of fraud, is defaulting on its debt covenants because it has missed deadlines to report its third quarter earnings. The company has not been able to get the earnings out because the investigation by its independent committee is taking much longer than expected. The committee is struggling to get information from Sino’s third parties, which are not all co-operating with the investigation.

While Sino could easily afford the US$9.775-million interest payment due this week, it is understood that the company does not want to treat one class of bondholders differently than the others. Now that Sino-Forest is breaching debt covenants, the debtholders can force a restructuring if investors holding 25% of the bonds file a notice of default.

The Richard Chandler Corp. is run by a billionaire activist investor of the same name. Mr. Chandler is known to take large positions in troubled companies and push for change. All the same, he surprised many onlookers by building a huge position in Sino-Forest after the company was accused of fraud. In fact, he bought 1.2 million shares of the company just two days before the stock was cease-traded by the Ontario Securities Commission in August.

The future of Sino-Forest Corp. hinges on whether bondholders decide to force the company into bankruptcy protection, a move that comes with massive risk and has no real precedent.

On Monday, Sino announced that it will miss a deadline this week to file its third quarter earnings, thus breaching covenants related to its US$1.8-billion of outstanding debt.

The hold up is due to another delay — the investigation by Sino’s special committee is not getting enough co-operation from Sino’s myriad third parties to complete its final report in the wake of fraud allegations.

Bondholders now face a decision: reach a negotiated agreement with the company on its debt, or enforce their rights to the assets. If they chose the latter option, experts said they face an incredibly complex task with no guarantee that they will get their money back anytime soon.

“The bankruptcy laws in China are very, very different than here in Canada,” said Alex Jurshevski, managing partner at Recovery Partners, a debt restructuring firm. “This would be the biggest cross-border Chinese Canadian bankruptcy.” He estimated that it could take 10 to 15 years in the Chinese courts to unravel the mess.

A key problem for the bondholders is determining what Sino-Forest assets they could actually sell. Last month, Sino’s independent committee stated that the company does own all the trees that it claims, but it could only produce proper title for 18% of them. Another question is whether they would actually be able to sell the assets in the byzantine Chinese marketplace.

“China doesn’t really have property rights. It’s not like these forests are here in Northern Ontario,” said Paul Battaglia, managing director at Trilogy Class Actions, which is considering a bondholder lawsuit against Sino-Forest.

The immediate challenge for Sino chief executive Judson Martin is to convince the bondholders that the company has a plan to become a viable again, and that forcing its hand would be counter-productive right now. “We will do everything within our power to maximize the return to our stakeholders and complete any work that is required,” he said.

But given the circumstances, Sino has hired Houlihan Lokey — advisors to Enron Corp. and WorldCom Inc. during their massive bankruptcies — as advisors to study its strategic options, including a recapitalization or outright sale.

If the bondholders want to force a restructuring, investors holding at least 25% of Sino’s debt would have to file a notice of default. Sino would then have 30 days to respond. The company has already warned that it is not going to make a US$9.775-million interest payment due this week. While Sino could easily afford the payment, it is understood that the company wants to make sure it is treating all its debtholders equally.

Sino-Forest’s $1.8-billion in debt consists of senior and convertible notes that are held by some of the biggest North American institutional investors, including Fidelity Investments, BlackRock Investments and Manulife Financial Corp. Distressed company investors don’t own large amounts of Sino debt, partly because of uncertainty regarding ownership of its assets.

Investors could have to wait a long time to find out what happened at Sino-Forest. The independent committee’s final report, previously due by year-end, has now been postponed to some time in 2012.

Carson Block, the short seller who accused the company Sino-Forest Corp. of fraud last June said bankruptcy is a “real possibility.”

Canadian securities regulators and law enforcement authorities grappling with a series of “challenges” posed by offshore companies listed on Canadian markets — mostly from China — may find some solace in that country’s zero-tolerance policy on commercial corruption.

On Nov. 9, Wu Jianwen, 42, the former president of the state-owned Shanghai Pharmaceutical Group was sentenced to death by a Shanghai court, with a two-year reprieve, for taking about $1.8-million in bribes and embezzling another $5-million over a 10-year period.

In September, a court in eastern China’s Shandong Province handed down a sentence of capital punishment against Wang Huayuan, who was convicted of taking bribes, abuse of power and for failing to explain the source of his personal assets.

And in July, two former senior Chinese government officials were executed following their convictions on corruption charges, marking the highest punishment meted out in recent years as the ruling Communist Party tackles public-resentment toward rampant graft in the world’s second-largest economy.

The two officials, former vice mayors of the prosperous eastern cities of Hangzhou and Suzhou, had been accused of taking millions of dollars in bribes in awarding contracts in the cities’ booming real estate markets.

Although most death sentences in China are commuted to life in prison with good behaviour, these punishments provide an interesting contrast to Canada’s treatment of white-collar crime.
To wit, Garth Drabinsky is appealing a five-year prison sentence — which will actually work out to less than 14 months in jail — for orchestrating an accounting fraud that cost investors of Livent Inc. about $500 million.

Most of the punishment meted out by Chinese courts involve government officials and those employed in state-owned entities.

However, according to an international survey on corruption, it still has an uphill climb. On a scale from 10 (highly clean) to zero (highly corrupt), China ranked 78 out of 178 countries examined in the Transparency International Corruption Perception Index last year. The global survey ranks countries by their perceived levels of corruption, as determined by expert assessment and opinion surveys.

Canada ranked sixth best among all countries in the survey, led by Denmark, New Zealand, Singapore, Finland and Sweden. The United Kingdom ranked 20th and the United States was 22nd.

The worst perceived corruption offenders in the survey were Somalia, which ranked last, Myanmar, Afghanistan and Iraq.

It’s against this backdrop that the Ontario Securities Commission is conducting a targeted review of emerging-market companies listed in Canada, focusing on 24 issuers from different industries and geographic areas.

The OSC’s goal is to develop new policy to handle some of the problems raised by clashing business practices, co-operation among regulators and how to enforce Canadian securities laws and regulations internationally.

In recent months, Canada’s top securities watchdog halted trading in high-profile cases involving offshore companies, including Sino-Forest Corp., which has timber operations in mainland China, and was the largest forestry company listed on the Toronto Stock Exchange at the time a cease trade order was issued in August. The company is also the subject of investigation by the RCMP.

On Tuesday, an independent committee of Sino-Forest’s board of directors issued a 111-page interim report refuting the fraud allegations leveled against the company by research firm Muddy Waters LLP. However, the panel of independent directors acknowledged they were unable to verify title ownership to no more than 18% of the company’s stated assets.

In the case of Zungui Haixi Corp., a Hong Kong-based sportswear company, the stock remains halted on the TSX Venture Exchange because no one from the firm showed up at a hearing before the OSC to oppose the cease trade order.

The trading ban, which was issued in September after Ernst & Young LLP suspended an audit of Zungui, was extended until a hearing Nov. 23 into allegations from OSC staff against Zungui’s chief executive Yanda Cai and chairman Fengyi Cai for failing to co-operate with the company’s audit and special committees and the securities watchdog.

The independent committee at Sino-Forest Corp. believes that the company is not a “near total fraud” or “Ponzi scheme.” However, while it provided some clarity on certain issues, it acknowledged some key limitations in its work, and only focused on the years 2006 to 2010. Here are a few of the key issues brought up in the interim report:

Timber ownership: The most damaging allegation in the Muddy Waters report was that Sino-Forest massively overstated its timber holdings. The committee said it was able to confirm 606,000 hectares out of the 833,000 reported by the company, or 77% of the stated holdings. It also said it confirmed the stated book value of the timber assets of roughly US$2.8-billion. But the committee relied on confirmations from Chinese forestry bureaus in its research, and acknowledged that it did “not obtain significant insight” into how the bureaus issue confirmations of ownership. The bureaus did issue a number of new confirmations following meetings with the committee.

Third parties: Sino-Forest says it sells trees to undisclosed customers called “authorized intermediaries” (or AIs), which provide very healthy margins for the company. The committee said it could it had trouble obtaining information from the AIs and other third parties that “are not compellable by the company or Canadian legal processes.” The third parties did have an “awareness” of the fraud allegations and were reluctant to be drawn into the investigation.

There was a specific issue around a company called Yuda Wood, which sold tens of millions of dollars of timber rights to Sino-Forest. According to Muddy Waters, Yuda is secretly a related party. The committee denied that claim, saying Yuda Wood employee Huang Ran is not currently an employee at Sino-Forest. However, it did find evidence of “close co-operation” between the two companies.

The committee also identified other situations where Sino-Forest may have close relationships with certain suppliers, while certain suppliers and AIs may have cross-ownership and other relations with each other. The committee said it recently received new information surrounding the issue of related parties, which is being reviewed right now It warned that the recorded value of Sino-Forest transactions “may be impacted” if they were done with related parties.

Co-operation from Sino-Forest: The committee had trouble getting co-operation from Sino-Forest executives, saying it initially was not provided with “significant” information it requested, particularly regarding inter-relationships with suppliers and AIs. In late August, the committee’s advisors conducted interviews with management to try and get some answers. The result was that four managers were placed on administrative leave (followed closely by former chief executive Allen Chan). It was at this time that the Ontario Securities Commission cease-traded the stock and said it found evidence of fraud.

Once those managers were ousted and Judson Martin was named CEO, the committee said it received much more co-operation from the company. Very recently, it has received additional information about AIs and suppliers that is currently being reviewed.

Cash: The committee confirmed a cash balance of US$571.1-million at Sino-Forest as of Nov. 4.

Chinese firms listed in the United States would be welcomed home, a senior Shanghai Stock Exchange official said, chiding the main U.S auditor watchdog and other American institutions for having politicised company accounting issues.

Zhou Qinye, the exchange’s vice general manager, said while only a few firms have real accounting issues, many overseas investors are short-selling Chinese companies for profit.

“The current situation is the result of some institutions seeking to politicise the matter, and it’s difficult to predict where things are heading,” Zhou told a conference, referring to a spat between U.S. and Chinese regulators over cross-border inspection of audit firms.

Shares in many overseas-listed Chinese firms have slumped this year after accounting scandals swirled around several China-focused companies.

Last week, U.S. securities regulators charged Chinese software company Longtop Financial Technologies Ltd with failing to file current and accurate financial reports.

Toronto-listed Sino-Forest Corp, which triggered a wave of selling in China-listed firms in June after it was accused of fraudulently exaggerating its assets, said on Tuesday that an independent committee found no evidence of such wrongdoing at the company.

Still, Zhou said Chinese firms listed abroad needed to improve investor relations management and learn more about the market environment and regulations. But they are welcome to come home, he said.

“One way is for overseas-listed companies to delist there and come back home, including Chinese and Hong Kong stock exchanges,” Zhou said. “For the Shanghai and Shenzhen exchanges, this could be an opportunity as we know that many overseas-listed Chinese companies are not bad. So we welcome those China stocks to return home.”

Some private equity firms have already started looking at the business opportunities related to bringing home Chinese companies which have suffered from the heavy selling.

Chinese firms seeking to list on mainland exchanges have various regulatory hurdles to clear, such as posting consecutive years of profit, but Zhou said the securities regulator was considering relaxing some of those rules.

James Doty, the chairman of U.S. Public Company Accounting Oversight Board (PCAOB), an auditor watchdog, repeated last week concerns about auditors’ inspections in China. He said the watchdog needs to gain entrance soon to China to inspect firms that audit U.S.-listed companies.

But the Chinese government has its own set of accounting rules and examination systems and cannot accept such a request, Zhou said, repeating Beijing’s stance on the issue.

Marisa Lago, Assistant Secretary for International Markets and Development at the U.S. Department of the Treasury, declined to comment to reporters in Beijing about any progress with the Chinese over the audit issue.

The U.S. has been heating up pressure for an early resolution, but some experts say such attempts will only backfire.

“They (the U.S. side) have politicized it. They’ve made it more difficult to seek a compromise,” said Paul Gillis, visiting professor of accounting at Peking University. “The solution has to come from China. There’s not much the U.S. can do, and the more the U.S. does, the worse it gets.”

TORONTO — Embattled forestry company Sino-Forest Corp. is under pressure to launch legal action against insiders who were barred from trading the stock by the Ontario Securities Commission.

The company, which is already facing multiple class-action lawsuits, said Friday that an investor asked it to file suit against employees named by the OSC, as well as a service provider and other “unidentified persons or entities.” The OSC has singled out five officials who are no longer allowed to trade the stock: former chief executive Allen Chan, Albert Ip, Alfred Hung, George Ho and Simon Yeung. Mr. Chan resigned, and the other four were removed from their jobs.

The shareholder request comes as the OSC and Sino-Forest’s own independent committee are trying to get to the bottom of what happened at the company. The committee revealed Friday it still plans to complete its investigation by the end of the year, but an interim report has been delayed until November. Sources said that the committee is struggling to work through thousands of complicated documents.

“The Independent Committee’s work is ongoing,” Sino-Forest said in a statement.
The OSC is in the midst of its own investigation, but it found enough troubling evidence that it cease-traded shares of Sino-Forest on Aug. 26 and accused some officers and directors of engaging in acts that they “know or reasonably ought to know perpetuate a fraud.” The cease-trade order is set to expire on Jan. 25.

Until Friday, Sino-Forest never indicated if it would consider a lawsuit against its own insiders. But after getting the request from the unidentified shareholder, the independent committee is going to study that option and make a recommendation to the board.

The shareholder told Sino-Forest that it may seek court approval to launch the lawsuit on behalf of the company if Sino-Forest does not co-operate with the request and commence the action on its own.

The nightmare for Sino-Forest began on June 2, when short-seller Carson Block of Muddy Waters LLC accused the company of committing many fraudulent acts. The shares plunged, and the independent committee and PricewaterhouseCoopers LLP quickly began their investigation.

Shares of many other Chinese companies trading on North American exchanges have come under pressure since the Sino allegations became public. Last month, the OSC also cease-traded shares of Zungui Haixi Corp., an athletic footwear company, after an auditor found irregularities in the company’s financials.

Sino’s largest shareholder is the Richard Chandler Corp., an activist investor. Other major investors are Davis Selected Advisers LP and Wellington Management LP.